Tesla’s Plan B 2.0; Y Not
Tesla's online-only sales model is chaos; the $35k M3 isn't $35k, so why not reveal Model Y?
Tesla (TSLA) as changed its mind, again, and now reportedly is putting on hold plans to close hundreds of its mostly newly opened stores and lay off thousands more employees—at least until the end of the month.
Employees, customers, suppliers, and investors still are reeling over Tesla's startling decision, announced February 28th, to move immediately to online-only sales, a dramatic reversal of strategy still in place as of the 2018 10-K filing on February 19th in which the company had touted growth via recent store expansions and substantial additions planned globally going forward.
Tesla explained that even with now three substantial price cuts on all its cars and now three significant layoffs since last summer, it must slash costs even more to support the launch of its long overdue $35,000 base version of the flagship Model 3 (see my report Tesla's New Plan: Buy Before You Try).
I warned clients that Tesla's stunning strategy reversal seemed driven more by alarming cash consumption plus much weaker than expected sales and profit margins already apparent in what is shaping up to be a disastrous first quarter—troubling trends that may continue.
However, as I noted, it also costs money to close stores, get out of leases (good luck with that), fire employees and redistribute remaining staff, and sell off fairly new equipment at steep losses.
Not to mention that shiny new Tesla stores suddenly going dark may appear ominously similar to retail stores going out of business seen increasingly all over the country—a bad look for Tesla, especially given customers already are spooked by its escalating quality, reliability, and service problems (see "Musk and Weird Q3 Developments Are Driving Investors to Telsa's Rivals" and "Tesla: Dave’s Not Here and Musk Won’t Leave" and Tesla: Down to the Wire" and Tesla - Truth and Consequences).
Tesla probably hasn't seen the light—it's just received as of March 1st a desperately needed cash infusion by finally securing overdue funding for Tesla Shanghai Gigafactory 3 which has been under construction since January (see Tesla: Shanghai Surprise).
Unfortunately, the four banks in Tesla's new "China Loan Agreement," which the company announced on Thursday with a rare 8-K filing, committed only to fund a one-year limited purpose loan for up to 3.5 billion yuan ($521 million). This is barely enough time or cash to get the Shanghai assembly plant up and running—much less also stave off the current cash crunch.
But Tesla must keep up appearances as well as bolster its liquidity through at least the end of the quarter as it gets ready to reveal Thursday evening the long-awaited Model Y—though I suspect this won't result in a massive burst of cash from new reservations as Tesla hopes.
Years of robbing Peter to pay Paul hasn't produced a sustainable growth model for Tesla, mostly because its business strategy still is better described as, "Wow, we didn't see that coming."
Hurry, Show Me the Money
The eagerly awaited Model Y will be a game changer for Tesla, which definitely needs to refresh its aging fleet, but it's a rose with thorns. First, the good news.
Model Y is a crossover, a much higher selling category versus sedans where industry sales have been fading for years. Tesla has bucked this trend so far given its early market innovations and the comparative lack of competition in this niche, but all of Tesla's models are years old now. Model 3 sales already are showing signs of slowing demand growth and sales of Models S and X have fallen into steep decline.
Model Y looks to be sexy, appealingly proportioned and, apparently, competitively priced, assuming a base price potentially less than $40,000 versus the base version of Model 3, per CEO Elon Musk's teaser tweet:
“Model Y, being an SUV, is about 10% bigger than Model 3, so will cost about 10% more & have slightly less range for same battery”
Elon Musk (@elonmusk) March 3, 2019
However, Tesla is launching Model Y in 2020 into an intensely competitive field of comparably exciting rivals produced by carmakers with significantly stronger balance sheets.
That's also when I expect consumer demand may be slipping further and faster amid eroding economic conditions in the US and overseas, just as global production capacity of electric vehicles potentially becomes saturated.
In any case, Model Y will likely take sales from Model 3 as well as aging Models S and X.
Model Y's biggest concern may be its 75-79% shared platform with the problematic Model 3 which already is scaring away buyers. Consumer Reports recently stripped its recommendation of the Model 3 due to serious quality and reliability concerns. I've been warning about quality controls curtailed and flawed cars increasingly delivered to customers (see "Musk and Weird Q3 Developments Are Driving Investors to Telsa's Rivals" and "Tesla: Dave’s Not Here and Musk Won’t Leave" and Tesla: Down to the Wire").
It's not surprising that Tesla also has struggled increasingly to keep customers happy as warranty service and repairs inevitably escalated as a result.
Continuing layoffs could make such problems worse since Tesla has targeted for reduction its more expensive—and more seasoned—employees which included the elimination of its quality control department at its primary factory in Fremont.
Insufficient staffing, weak quality control, and notoriously poor management oversight could aggravate Tesla's atrocious manufacturing safety record, already dramatically worse versus all other US automakers combined:
Model Y may have new problems of its own. Tesla's track record and persisting liquidity struggles suggest it will be launched with minimal testing and built with comparatively inexperienced workers in Gigafactory 1 in Nevada and in Shanghai Gigafactory 3.
In Shanghai, Tesla's poor manufacturing record will be further challenged with cultural differences plus China's notorious reputation for poor build quality.
It doesn't help that Tesla's Vice President of Engineering Michael Schwekutsch has suddenly resigned, another of more than 50 senior Tesla executives to leave abruptly over the past year. This comes as the company is ramping up production with the new $35k Model 3, planning and implementing new production in the US and in China for Models 3 and Y, and preparing to unveil the new Pickup this summer.
Model Y sales (all Tesla sales, actually) will suffer from Tesla's chaotic sales strategy. As I noted in my last report, startup innovators like Carvana Co (CVNA US) have demonstrated success with online sales in the used car market.
However, new car sellers have had mixed results at best and even Tesla, which has reported some 70-80% of its sales are online, continues to see customers coming to the stores to see and test drive cars before finalizing sales.
In any case, moving to an online sales model would be challenging enough even with well-informed, well-tested and, especially, disciplined execution—none of which have ever described Tesla. Nor has Tesla ever been known to be consistent, so who knows what its strategy will be a year from now?
Model Y may not draw the dramatic burst of reservations—precious cash—Tesla needs right now. Buyers waited 2-3 years for the Model 3, with some waiting by the phone nearly a year longer for the base $35k version as more expensive models were produced first. Tesla has been taking reservations for the Semi and the Roaster since 2017, and they won't be produced until 2020. Moreover, Tesla's chronic liquidity problems threaten the ultimate quality of the Model Y as well as its release date.
So, buyers may decide there's no need to rush in with a $2,500 early bird deposit to wait for an indeterminate period for another untested product of dubious quality.
In the meantime, Tesla's financial viability remains in question—a good reason for investors to remain wary as well.
Maintain “Underperform” on TSLA 5.3% Senior Notes due 2025, down 3 points over the past couple of weeks at 86.5 (8% ytw; 559 bps). That’s a meager 102 bps of spread per turn of estimated leverage in 2019 on potentially increased borrowing to offset cash shortfalls—hardly adequate compensation for such a volatile issuer with such precarious prospects. Given Tesla's persistent uncertainty and escalating risks we could see 3-5 points additional downside from here.
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